Diversification should be the main reason to invest offshore

Many South African investors are asking whether there is any benefit to investing offshore now that the domestic economy seems to be on the upturn.

It always makes sense to invest a portion of your wealth offshore. South Africans typically expatriate their money when pessimism about the country is at its peak and repatriate their money when the consensus regarding South Africa is overwhelmingly positive. This results in significant investment losses as the rand fluctuates.

Many people overlook the benefits of diversification associated with investing in global equities. The role of an investment portfolio is to reduce risk, which is particularly relevant when the assets out- or under-perform at different points in the market cycle.

Although the expected return of a portfolio will be lower than the return of the assets, the purpose of investing offshore is to reduce the concentration risk that comes with exposing all your investments to one market.

This strategy works particularly well if the assets in your portfolio under-perform at different points in the market cycle.

In this instance, the risk of the portfolio can be below the weighted average risk of all the assets in the portfolio. This holds true for the MSCI All Country World Index and the FTSE/JSE All Share Index (indices representing the global and South African markets respectively), because since 2008 their rolling annualised five-year returns have shown a low correlation with each other.

Better diversification is not the only reason investors should invest globally. Investing offshore offers South African investors a world of growth opportunities.

Why would you want to limit yourself to an investable universe of $1.2 trillion (R14.35 trillion), which is the market cap of the JSE, much of it concentrated in a handful of companies, when you could be investing in a universe of $79 trillion in which no single share accounts for more than 1%?

This includes great companies such as Coca-Cola, Google and Microsoft, whose products the average South African uses every day. When last did you drink a soft drink that wasn’t manufactured by Coca-Cola, use a search engine that wasn’t Google, or use a spreadsheet that wasn’t Excel?

These businesses have the added benefit of being globally diversified, so the degree to which they are affected when one country invades another (think Russia and Ukraine), or when one country is boycotted by its neighbours (think Qatar), or when a finance minister is replaced (think South Africa), is very small indeed.

Finding value

A potential risk of investing offshore is that global markets are currently expensive.

Looking from the top down, this is true, but there are many companies that individually offer value. An example of this is Legal & General, an insurer in the UK, which trades on a low forward price/earnings multiple of 11 and a dividend yield of 7%, even though it is growing at high single to low double digits.

Even some of the shares that look expensive, such as the so-called “FANGs” (Facebook, Amazon, Netflix and Google), are far cheaper if you adjust for the multi-decade growth opportunities that are available for them to exploit.

A share that can grow its earnings more than 20% a year doubles its earnings in just over three years because of the benefit of compounding, and one that can grow more than 50%, as Facebook did, doubles its earnings in less than one-and-a-half years.

The only sensible investment strategy for the average person is to decide what portion of their monthly savings they want to invest globally and what portion in South Africa, and to keep this percentage stable, regardless of what happens in South Africa.

At Old Mutual Titan, we follow a long-term valuation-based investment philosophy. Although we are always cognisant of the price we are paying for assets, and through this discipline avoid becoming embroiled in market greed or fear, we prefer to invest in good businesses that we spend time getting to understand.

We believe this strategy delivers the best returns for our clients over meaningful time periods, which we define as five years or more.

Kyle Wales is a portfolio manager at Old Mutual Investment Group’s Titan boutique.